Life-time job security with generous fringe benefits have increased youth unemployment by discouraging French employers to hire new workers and encouraging them to substitute capital for labor.

Young people led by vocal students are protesting the new French law that allows companies with fewer than 20 workers to lay off employees within two years of their hiring without any justification. Without the new law, employers have to jump through hoops just to lay off workers. The idea of the new law is to encourage small businesses to hire more young workers without the fear of getting stuck with them. Indeed, the youth (age 15-24) unemployment rate at 22% (Economist) is dismal by international standards.

On the surface, it is strange why young French people would prefer no jobs to insecure jobs. And why the job aspiration of young French people is so low that they eagerly look forward to lowly government jobs with secure fringe benefits.

But the new law does nothing to reduce the life-time job security of existing workers with generous fringe benefits. So the new law has the effect of further entrenching the two-tier labor market. In other words, the ins are forever in, and the outs are forever out. The length France goes to to protect job security of the “ins” is illustrated by its attempt to spread work around by criminalizing working longer than 35 hours per week.

The high French youth unemployment rate is the direct result of an inflexible labor market where wages and employment do not adjust to changing market demands. When workers cannot be dismissed and wages cannot be lowered due to falling demand, labor costs become a fixed cost. And if labor is a high and inflexible cost, there is every reason to substitute cheaper capital for labor. The result is ever fewer new jobs and lower rate of return to capital due to excessive capital deepening.

That job generation cannot be robust unless the whole labor market is flexible is demonstrated by the Spanish experiment of short-term employment contracts with little benefits and no severance pay. On the surface, Spain’s experiment has been very successful in reducing the unemployment rate from 20% to 9.4% over the past decade. But these short-term jobs pay barely above minimum wages and create little human capital because companies skimp on training short-term employees.